Harmonic patterns can be used to spot new trading opportunities and pricing trends.
Harmonic patterns are chart patterns that form part of a trading strategy – and they can help traders to spot pricing trends by predicting future market movements. They create geometric price patterns by using Fibonacci numbers to identify potential price changes or trend reversals. Traders can identify these patterns and use them to inform their next trading decision.
1. The ABCD pattern:
- The ABCD (or AB=CD) pattern is composed of three movements and four points.
- First, there is the impulsive movement (AB), then a corrective movement (BC)
- then another impulsive movement (DC) that goes in the same direction as AB
- Using the Fibonacci retracement tool on the AB leg, the BC leg should reach precisely 0.618.
- The CD line will be the same length as the AB line, and the time it takes for the price to go from A to B should be equal to the time it takes to go from C to D.
- Traders can choose to either place their entry orders close to the C point, which is defined as Potential Reversal Zone (PRZ); or they can wait until the entire pattern completes before taking a long or short position from the D point.
2. The BAT pattern:
- The BAT pattern gets its name from the bat-shaped end product.
- It has one leg more than the ABCD pattern, and one extra point, which we will call X.
- The first leg (XA) will lead to a BC retracement movement.
- If the retracement up to point B stops at 50% of the initial XA movement, then you are probably looking at a BAT pattern.
- The CD extension must be at least 1.618 of the BC keg and can reach as high as 2.618. The CD extension must not be less than BC’s, otherwise the figure is invalidated.
- The end point (D) creates the PRZ, which means that traders can open their positions to trade either a bullish price reversal, or a bearish price inversion.
3. The Gartley pattern
Created by HM Gartley, the Gartley pattern has two key rules:
- The retracement of point B must be 0.618 of XA
- The retracement of point D must be 0.786 of the XA movement
It is similar to the BAT pattern in that the XA leg leads to a BC retracement, except that the retracement of point B must be precisely 0.618 of XA. The stop-loss point is often positioned at point X, while the take-profit is often set at point C.
4. The butterfly pattern
The butterfly pattern was discovered by Bryce Gilmore who used different combinations of Fibonacci ratios to identify potential retracements. It is a reversal pattern composed of four legs, marked X-A, A-B, B-C and C-D.
The most important ratio to define is the 0.786 retracement of the XA leg. This helps to plot point B, which will help traders to identify the PRZ.